States in tax reform’s front line

One of the business lobby’s key regrets about last week’s budget was that it seemed to walk away from tax reform, abandoning several previously-announced initiatives with no hint of returning to the noble cause down the track.

Running under the surface of the budget numbers, though, was another message: manning the tax reform front line is being left to the states.

That was never spelt out, but there was a big hint in the downgrading of GST collection expectations. While the states squabble over sharing the GST cake, the cake shrinking by $11 billion or so focusses attention on the main game: they’re heading towards a fiscal brick wall.

Canberra is in no position to bail them out. Tax reform requires the expenditure of political capital as “reform” no longer means “cuts” – our demographics and tax base mean any reduction of tax in one area for the sake of greater efficiency and/or equity requires an increase of tax in another for the sake of greater efficiency and/or equity, or a significant cut in programs to which some part of society believes it’s entitled.

Labor has no political capital left with which to handle those sectors that might lose an entitlement or two. The coalition is still in the fanciful land of opposition where anything can be promised, including the Hockeynomics Magic Pudding of tax cuts, tax increases, tax repeals, a lazy $50 billion in further expenditure cuts and increased spending on everything from maternity leave to infrastructure.

It’s a nice follow-up to the Member for North Sydney’s attack on the entitlement mentality in the struggle to contain Abbott’s promises, but never mind, after the election, the inevitable briefings from Treasury and the RBA will provide the excuse for the equally inevitable breaking of those promises in order to deal with the reality of government.

(I can already hear the cadence of Prime Minister Abbott addressing the nation with heavy heart and furrowed brows: “We have been devastated by the briefing we’ve just received from Treasury and the Reserve Bank, absolutely devastated. We knew Labor was bad, but we had no idea just how bad. The extent of the black hole they have created in our accounts will take years to fix. It sorrows me greatly, but given the crisis we find ourselves in, we have been forced to delay the implementation of some of our policies. It would simply be grossly irresponsible of me to do otherwise. So that maternity leave aspiration...”)

Thus necessity remains the mother of invention – and reform. The bipartisanship pledge of fiscal rectitude in Canberra means there’s no interest in or capacity for saving the states from their looming crisis of rising expenses colliding with a limited tax base.

Federal Treasury secretary Martin Parkinson was a little more direct in his post-budget speech when he pointedly repeated a warning he made back in March. He was being apolitical on Tuesday when he told business economists:

“Governments at all levels face difficult fiscal circumstances for the foreseeable future, with razor thin surpluses at best in the absence of conscious decisions to raise additional revenue or cut outlays.

“Efforts to reduce outlays are likely to be more effective, and sustainable, if nested within a broader assessment of the roles and responsibilities of the different levels of government, an approach that could help sharpen the focus on duplication, overlap and inefficiency. In this regard, the announcement at the recent COAG meeting that the Commonwealth and the States will work cooperatively to ensure that State environmental approval processes can satisfy Commonwealth obligations, reducing duplication and double handling, is a good initiative.

“However, even total success in minimising overlap will not address the key challenge — the gap between the expectations of government held by the Australian public and the public’s willingness to pay what’s required if those expectations are to be met.”

Parkinson went close in that final paragraph of belling one of our great political lies, told by both sides: Australians can expect to get more from government while paying less for it.

It’s the states that have to face that first, being in the front line of much of our service delivery. Aside from the bottomless pit that is health, the need to invest more in education and playing catch-up on infrastructure investment, the states face the tide of aging baby boomers with limited revenue options that range from those collecting less than expected (GST) to those that have been debased by electoral bribery (payroll tax) to the simply bad (the economically damaging stamp duty).

One of the lessons of last year’s tax forum was that all the state treasurers knew stamp duty on real estate transfers was a bad tax and that Henry was right in preferring a broad-based land tax, but not one of them was game to deal with the politics of reforming it, all of them wanting the Feds to do the unpalatable stuff for them.

(A promising exception that has largely passed under the national radar is Canberra itself: the ACT administration has broadly accepted the findings of its own taxation review, including the scrapping of “fundamentally unfair” stamp duty and replacing it with a broad-based land tax, moving the $300 million annual revenue grab from buyers to owners. The review recommended a 10-year phase in with the government’s official response coming in the ACT budget next month.)

The federal government meanwhile has its own priorities. Martin Parkinson held out the suggestion that more efficient government would help, but immediately stated that it wouldn’t solve the problem of expectations that have been built up by politicians feeding voters variations on the theme that they deserve more from government – whether it’s tax cuts and special assistance for corporates or cash handouts for parents and increased medical entitlements. By one means or another, tax cuts remain something of the Holy Grail for federal politicians.

Parkinson referred to the demographic imperative on Tuesday in justifying the rush back to budget surplus in 2012-13:

“With substantial risks remaining in the global economic environment, it is critical that we move now to recharge the fiscal batteries while circumstances remain favourable. By doing this, we will ensure that we retain the fiscal capacity to respond to future adverse shocks where needed as well as long-term trends such as those highlighted in the intergenerational reports.”

With the ratio of those aged 65-plus to the working age population in the process of falling from roughly 1:5 to 1:2.7 by 2050, never mind the longer time people are spending in education, those long-term trends are compelling and at some stage apply a blow torch to revenue raising, however politically unpalatable.Parkinson went further down that road in a speech on March 9:

“The task of maintaining medium-term sustainability for both the Commonwealth and the States has been made harder by developments in the revenue base. Indeed, for both levels of government, surpluses are likely to remain at best razor-thin without deliberate efforts to significantly increase revenue or reduce expenditure.

“This predominantly reflects the sharp weakening of revenue collections over recent years.

“The tax-to-GDP ratio has fallen by 4 percentage points since the GFC, and is not expected to recover to its pre-crisis level for many years to come. This reflects a combination of cyclical and structural factors. Capital gains tax has been hit hard in the aftermath of the crisis.

"Households are more cautious in their spending pattern, dampening indirect taxes in the process. Meanwhile, the resources boom and the increasing importance of the mining sector is having significant impact on tax revenues.

Mining companies account for about a fifth of gross operating surplus, yet only around a tenth of company tax receipts, primarily because tax receipts from the industry are affected by the high levels of investment occurring in the sector and the consequent level of depreciation deductions. Finally, the historically high Australian dollar hurts profits in, and taxes from, the non-mining export, and import-competing, sectors.

“With muted growth in tax receipts projected for much of the next decade, Australia will need significantly greater expenditure restraint in the decade ahead than was seen in the first half of the 2000s if we are to deliver the sort of fiscal outcomes likely to be required for sound macroeconomic management and as we pay down debt.”

There’s a solid slap there and in Tuesday’s speech at the Howard/Costello budgets that were too busy handing out income tax cuts and building up middle class welfare payments to provide the fiscal drag the economy required at the time.

So the states have to tax more or spend less, or both. Given those drivers, it makes sense for them to first of all tax smarter.

Michael Pascoe is a BusinessDay contributing editor

P.S. In a comment on Monday’s article on the absence of a population forecast in the budget when net overseas migration is surging, an especially diligent reader or, I can’t help suspecting, a Treasury-type actually involved compiling GST estimates, correctly points out that there was a figure tucked away very deep in Paper No 3, page 125 of the section on Australia’s federal relations.

The number though seems more like an extrapolation rather than a forecast, is for the calendar year and, on the available evidence, looks like being wrong.